Member Article

Independent expert reports are commissioned by company directors to assist shareholders in assessing a broad range of M&A transactions, including takeover bids, schemes of arrangement, related party transactions and shareholder approved acquisitions over 20%.  The purpose of the reports is to provide shareholders with an objective assessment of whether the proposed transaction is 'fair and reasonable' from their perspective.  Sometimes an independent expert report is required by law or ASIC policy.  At other times the proponents of a transaction will voluntarily commission an independent expert report to give shareholders a level of objective assurance about the commercial merits of the proposal.  

But there is a perception among shareholders, other market participants and the press that independent expert reports are often not as objective as they're held out to be and that the expert's valuation and conclusions predictably coincide with the directors' own recommendations.

ASIC's role

In most cases where an independent expert is engaged in M&A transactions, ASIC will review a draft of the report before it is publicly released.  During this vetting process, we have found that that independent expert reports are coming under increasing ASIC scrutiny, often leading to significant changes to methodology and/or valuation before the report is finalised and publicly released. 

These sorts of changes during the ASIC review process can lead to transaction delays and even execution uncertainty.  For example, when market conditions are particularly volatile, a delay of several weeks in finalising an expert report to address ASIC concerns can jeopardise the transaction, as well as escalate costs. 

Emerging tensions

Market participants have been calling for ASIC to improve its policy guidance for independent expert reports.  At the same time, ASIC has expressed increasing concern about expert reports which it believes contain serious deficiencies in valuation methodology and/or an absence of independence. 

The Australian Financial Review reported ASIC Commissioner Belinda Gibson's view that 'When we see such reports we step in – independent expert reports are too important to let deficient ones go out to investors.'

A path towards resolving the tension

On 30 March 2011, after extensive public consultation, ASIC released updated guidance aimed at enhancing the reliability and quality of expert reports.  ASIC's updated guidance seeks to:

• ensure that the expert is truly independent of the commissioning party 
  
• ensure that the expert’s conclusions have a reasonable basis and that any assumptions in the report are fully stated
  
• ensure that experts have a reasonable basis for forward-looking statements  
  
• clarify the use of the discounted cash flow valuation methodology, particularly when valuing a start up project where there is a long lead time until cash is generated. The expert must have a reasonable basis for the forward looking information and be explicit in disclosing the extent and nature of the adjustments made to allow for development stage risks
  
• provide additional guidance on how experts should assess whether a proposal is fair and reasonable. It requires experts to explain any material difference between their assessed value of a security and the recent market price of the security.

Overall, ASIC's aim is to improve the quality of expert reports so that investors have greater confidence in their objectivity and methodology.

It remains to be seen whether ASIC's updated guidance will result in less regulatory intervention in independent expert reports.  In some ways this seems unlikely - experts often emphasise that certain aspects of a valuation analysis do not lend themselves to precise or objective quantifications but rely instead on the skill, expertise and professional judgment of the valuer. 

This article is from our September 2011 edition of Mergers & Acquisitions newsletter.

• Key points

• Independent expert reports are a prevalent feature of M&A transactions but their objectivity and reliability have been increasingly questioned.
• ASIC's review of draft independent expert reports often produces substantive changes which can delay transactions.
• ASIC has issued updated guidance to raise the standard of expert reports and address concerns about perceived independence.